Fed Insider Loretta Mester on Rate Cuts and Inflation, Plus Tech Earnings and Tax-Time Surprises
On this week’s Best of Simply Money podcast, Bob and Brian welcome former Cleveland Fed President Dr. Loretta Mester for a rare insider’s view into how interest rate decisions are made, why 2% inflation remains so elusive, and how the Fed stays focused amid political noise. She also recounts navigating the economy through COVID and shares what makes Ohio’s economy uniquely resilient.
Then, Bob and Brian shift gears to dissect huge earnings reports from Microsoft, Meta, Alphabet, and Nvidia — and what they signal for the future of AI and market momentum.
Later, they tackle real-life listener questions: why muni bonds might trigger “phantom income,” how mutual funds can lead to unexpected tax bills, tips for coordinating insurance policies, and whether investing through an LLC offers tax or liability advantages.
Download and rate our podcast here.
Bob: Tonight, a special treat. We've got one of the most influential voices in American monetary policy on the show right now. You're listening to "Simply Money", presented by Allworth Financial. I'm Bob Sponseller along with Brian James.
If you follow the markets at all or even just have a mortgage, then you know that the Federal Reserve plays a massive role in your financial life. But the conversations that happen inside those closed door meetings in Washington, most of us never get to hear from someone who was actually in the room. That's why tonight is so special.
Until the middle of last year when her 10-year term concluded, Dr. Loretta Mester served as president and CEO of the Federal Reserve Bank of Cleveland, where she actually cast votes that directly shaped interest rates in the direction of the U.S. economy. And for those that don't know, the Cleveland Fed has a branch right here in Cincinnati. Dr. Mester currently is an adjunct professor of finance at the Wharton School of the University of Pennsylvania. Prior to joining the Cleveland Fed, she served at the Federal Reserve Bank of Philadelphia. And as if she does have any spare time, in her spare time, she serves as a trustee of the Cleveland Clinic and of the Musical Arts Association in Cleveland. Dr. Mester, it is a real treat to have you with us. Thank you so much for making time for us tonight.
Dr. Mester: Thanks for having me on. I'm really looking forward to the conversation.
Bob: Great. Well, hey, the timing of your being with us could not be much better as the Fed, as you well know, just voted to lower interest rates by a quarter of a percentage point yesterday. Do you have any reaction to that move? Are we on the right track here? And more importantly, and I've heard you interviewed on this through other media channels, give us a taste of your sense of the balance that the Fed is trying to strike here between getting inflation back down to that 2% target and balancing that with the health or lack thereof of the labor market.
Dr. Mester: Well, you're exactly right. I mean, the Fed does have a dual mandate goal, so called, that the Congress has given it. It has to hit price stability, which it defines as 2% inflation, and it has to set policy also to support getting the maximum employment. And so, balancing those at times can be challenging. And this is one of those times because, as you pointed out, the labor market, it's in a balance. I would call it an uneasy balance in that there isn't a lot of hiring going on, but there also isn't a lot of hiring going on. And so, you have sort of an equilibrium there for businesses where they just don't add a lot of people to their payroll because they don't want to get caught out with too many if the economy takes a turn. On the other hand, you also have inflation that after the surge, after the pandemic, you know, when the inflation went up really, really high to high levels, over 7%, hasn't ever come back down to the goal of 2%. And the Fed's been working hard to try to get that to come down.
So, they have to have both of those goals in their sights. And that's what they've been trying to do. Last meeting in September, they started to reduce interest rates, their policy rates, and they followed through with another rate cut this week, just yesterday. And so, you know, they're trying to take out some insurance on the labor side of their mandate, while at the same time, keeping some, you know, pressure to get inflation back down. And that's hard to do when you have the economy performing as it is. But so far, you know, that's what they're trying to do. And as the chair said yesterday in his press conference, Chair Powell, they're not sure what they're going to do in December now. You know, they'll have to wait and see how the economy evolves to see whether they need to do more or whether they're going to stand back.
Brian: Dr. Meister, it seems like we've been stuck at 3-ish% inflation for a long time now. And for an uneducated mind like myself, it almost feels like 3% is the new floor, especially since we decided to go ahead and start cutting interest rates, you know, before we got down to our preferred 2%. Why was it so much easier to get down from the crazy 9% down to 3%, but this last mile is so difficult? What would you say is the biggest hurdle to that?
Dr. Mester: Well, you're exactly right. And we have been sort of very, in some sense, stuck at 3%. You know, last year, they started to bring the interest rate down because they thought inflation was on its path down to 2%. You don't want to wait until inflation gets to 2% to move monetary policy into a more neutral stance because then, you'll overshoot, and have, you know, inflation prices keep falling. And that isn't necessarily good for the economy either. But you're right, and I have some concerns about the inflation numbers that, you know, they've been having a view that, you know, most of it is tariffs, right? So, when firms have to face higher costs to bring goods into the country, they'll increase their prices to consumers to try to make up for some of that higher cost.
And so, they've been saying that they think most of the inflation has been this care for later inflation, and they view that as being sort of a temporary phenomenon that'll go away. However, I think if you delve under the hood, you see that it's not just tariffs, that it's service prices, especially if you take out housing prices, which are starting to move back down. And so, I think they do need to be very watchful of that and not go too far on their rate cuts, because then, they'll embed that inflation in the economy. And as you point out, it's already been, you know, four and a half years since we've gotten inflation back down 2%, you know, has been at 2%. So, again, there is a difficult row to hoe, and they have a challenge in front of them. And so, that's why I think they really need to be focused on inflation and the labor market, not just on one of those two balls. They need to keep both on their site.
Bob: You're listening to "Simply Money" presented by Allworth Financial. I'm Bob Sponseller along with Brian James, joined by Dr. Loretta Mester, the former president and CEO of the Federal Reserve Bank of Cleveland.
Dr. Mester, we want to get into a little bit of your actual time serving on the Fed. I mean, let's face it, you served on the Fed as president of the Cleveland Fed during some interesting times. You served during most of the Obama administration, the first Trump administration, then almost all of the Biden administration. So, pretty interesting times, to say the least. And among the most interesting times, you were on the Federal Reserve helping us guide the country through COVID, one of the most historic periods in history and certainly a gut punch to the economy. Take us behind the scenes of how you tried and your colleagues operated during a time when, you know, let's face it, we weren't sure what was going to be going on here with this pandemic.
Dr. Mester: Well, you're exactly right. It certainly was nothing that any of us had experienced. And it was very uncertain. I mean, I think people sometimes forget, given that we're now five years beyond how uncertain it really was. And we didn't really understand what was going on, especially in the beginning. I remember sitting in a conference in New York after having gotten back from London early in March, and we were like sardines in a can. And I'm thinking, like, now, wow, that was pretty risky thing to do. But you didn't know at the time. And so, you know, we, as I said, all of the policymakers and all the staff at the Fed really hunkered down to really try to understand what was happening to the economy because we wanted to do what we could with our policy tools to support the economy as best we could.
And I have to give credit to all the business people that I talked to during those times because we really didn't have a clue about what was happening. It was really important for us to gather that information and from bankers and business people and labor market leaders in our district, you know, which includes Cincinnati, of course, as you mentioned, we have a branch there. People were so generous. You know, they were worried about their own business, their own family, and yet they were incredibly, you know, generous with their time and intel and telling us what they were seeing out there.
And I actually had the opportunity to serve on a non-partisan, a political council that Governor DeWine put together because he wanted to gather people who were really in the understanding, trying to understand what was happening in the economy in Ohio. And that was also, I felt like I could provide, at least, our insights from the Fed side in terms of what we were seeing in the economy, but also hearing from the business people on that. So, it was a very uncertain time, I would say. But I mean, one thing about the Fed is that everyone at the Fed is very dedicated to doing what he or she can do to support the economy. And, you know, as you saw in yesterday's meeting, not everyone has the same view necessarily, what is the best path? But everyone brings their ideas to the table, and then they discuss them. So, that was what we tried to do during the pandemic.
As you know, you know, the Federal Reserve banks, including the branch in Cincinnati, stayed open because we had to move cash. It was very important that people have access to cash during uncertain times and, in fact, demand for cash. And a lot of people go around today not having cash in their pocket. They don't have dollar bills in their pocket. They use their phone or, you know, credit cards or debit cards. But during those kind of uncertain times, people want cash. They want to physically have something in their hand. And so, that was really important. And all the workers in our cash operations, they were dedicated coming in, even though they were scared for their own family. You know, they were really dedicated to making sure that the financial system stayed afloat, including the payment system.
Brian: Dr. Meister, I want to ask you about something a little more recent. This Fed, this happened after your term, but just a few months ago, Erika McEntarfer, the commissioner of the Bureau of Labor Statistics, was let go from her position after a less than desirable July employment report, which isn't necessarily attributed to any one person. And then some other changes with regard to how we collect data, how we distribute it. So, you weren't in the role, of course, at the time. But what were your thoughts when you started to hear the news about how we were changing the information that people such as yourself were going to have in order to make decisions? What are the biggest things that you thought, "Oh, my gosh, how are they going to function without this kind of thing?"
Dr. Mester: Well, it is certainly true that the government's economic statistics, the Bureau of Labor Statistics, you know, have published both inflation data and employment data. Those reports are, you know, top notch reports on the U.S. economy. They give you a very good picture of what's happening in the economy. And, you know, not to have that data is a disadvantage. Now, on the other hand, there are other data sources that the Fed has available to them. Some of them are private sector data that are available to everyone. And also, the Fed collects its own data.
So, you know, before every, you know, meeting on interest rates, the Fed actually publishes what it calls the beige book. I'm sure you have seen that before and many of your listeners probably have seen it. And it's really a summary from every Reserve Bank of what they're seeing and hearing from contacts in the district. And it's a summary of the economy. And we put that out, the Fed puts that out before the FOMC meetings so everyone can share. I am sure that the Reserve Banks have really stepped up those efforts, given they don't have the gold standard of data from the federal government. And a lot of the Federal Reserves, including the Cleveland Fed, do their own kind of surveying of businesses, and then amalgamate them into indicators and put them out to the public to see as well.
So, I'm sure there's been very big effort going into sort of collecting that intel so that they do have a basis for understanding what's happening in the economy, and then also, what they can expect to happen in the future. And that's where the boards of directors of the Federal Reserve Bank and business advisory councils... When I was at the Cleveland Fed, we ran a lot of business advisory councils that were geographically or industry focused so that we would have those contacts to be able to ask people, "Hey, what do you planning to do with your prices? You're facing higher tariffs. Are you planning to pay for some of that by reducing your margins? Do you have that money to do that? Are you planning to pass them on to your customers? And do you think you'll be able to do that while customers demand space for your product?" And so, you have that as a real avenue for gathering information that can be very useful for policy.
Bob: All right, Dr. Mester, we got to take a short break. I know you're going to hang with us for a few more minutes, which we really appreciate. You're listening to "Simply Money", presented by Allworth Financial on 55KRC, THE Talk Station.
You're listening to "Simply Money", presented by Allworth Financial. I'm Bob Sponseller along with Brian James. If you can't listen to "Simply Money" every night, subscribe and get our daily podcast. Just search "Simply Money" on the iHeart app or wherever you find your podcast. We are back and continuing our conversation with Dr. Loretta Mester, who served as president and CEO of the Federal Reserve Bank of Cleveland from June of 2014 through June of 2024.
Dr. Mester, I've got a question I'm dying to hear your answer to. You know, obviously in the current environment... And we've already talked about, you've served under three different administrations. Now, we have the second Trump administration where he has wanted to kind of try to, for lack of a better term, direct Fed direction on true social. Give us the real answer on how this actually works behind the scenes, how the Fed governors actually communicate. Are you guys actually influenced at all by all this noise out there? How does it really work? I mean, you gave us a lot of reassurance about how the Fed operated during COVID. Talk about what it's really like here when all this, you know, what I'll say, rhetoric is flying around. Is that just noise that you all just tune out when you're actually doing your job?
Dr. Mester: Certainly, you tune all of that out. I am very confident that when each policymaker enters that room where they sit around the table to deliberate what's the best path for monetary policy, none of the outside influences affect how they're going about making their decisions. That said, I think it's very unfortunate that... You know, even that you had to ask me that question just shows how unfortunate a situation we're in. Because, you know, in the past, you know, presidents have tried to influence the Fed. Typically, it happens during election years where they want to gin up the economy and they would love to have you through the economy growing as they enter an election, and then they're less worried about inflation because that comes later. And that has happened in the past under other presidents in history.
But what's different this time is that it's so in the open, it's so unrelenting, and it's so vitriolic. And so, this is an unfortunate situation because it does lead to skepticism about how the Fed actually goes about making its decisions. But I know in that room, none of that answers. This is really about sitting on the table, deliberating what they're seeing in the economy and their various districts and for the nation. And what they believe with their tools is the best path for them to set that industry. And so, again, it's an unfortunate situation.
You want the Fed to be able to make its decisions independent of all these short-run political considerations because it actually leads to better monetary policy. There's lots of work in various countries that basically show, and in the U.S. as well, that when the central bank can make decisions based on what's best achieving price stability and maximum employment if that's part of their goal, you actually get lower inflation, and you don't have to pay a price into having more volatility or business cycle fluctuations on growth or unemployment. You actually get better outcome for the public. And so, that's why you really want to have the Fed be able to make its decisions without this influence attempt. And that's what's so unfortunate, it's a distraction that isn't helpful in any way.
Brian: Dr. Mester, you spent a lot of time in Ohio, and then, of course, you were responsible for a lot of the Midwest in your role. What do you see currently about this area in terms of opportunities, threats, and those kinds of things? Is Ohio specifically well positioned to navigate all this economically, or do you see challenges here?
Dr. Mester: Well, Ohio has a lot going for it. I mean, it was more manufacturing based than other parts of the country, and certainly, has more ties also to the auto industry. But on the other hand, it also has a very important service sector, including education and including health care. The Cleveland Clinic, of course, I'm on their board. They certainly are at a forefront in the nation and the world on health care. So, that's what's great about the district in Ohio. It's really that it has a very diverse economy. And diversity of your economy is what you want because then, you can get through periods where maybe the tariffs are challenging some manufacturing firms. But on the other hand, health care is still going to be in demand. Again, having diversity is very important, and that's what Ohio has.
The educational part of Ohio is also very important because it's creating the workers of the future, and that's very important. On the other hand, there are a lot of businesses doing a lot in terms of internship programs, the apprenticeship programs, so that we have sort of the workforce that can do a lot of the jobs that are going to be necessary as the economy evolves in the future.
Bob: It has been a huge week for company earnings. We're going to talk about that and later take your questions. You're listening to "Simply Money", presented by Allworth Financial on 55KRC, THE Talk Station.
You're listening "Simply Money", presented by Allworth Financial. I'm Bob Sponseller along with Brian James. When the companies that make up a third of the S&P 500's total capitalization make earnings announcements, it's a pretty big deal. Good news will drive the market, and the reverse can happen as well. So, let's delve into some of these actual companies, Brian, because we are getting some earnings news, you know, coming out as we speak. And we've gotten earnings over the last couple of days from some of these big tech giants.
Brian: Yeah, the big companies are producing their report cards here. So, let's start with Microsoft. Microsoft reported better than expected results for the fiscal first quarter. Revenue in the company's Azure cloud business jumped about 40%. That's obviously a pretty good run. And they're heavily involved in the AI revolution using Azure as well as OpenAI, which is the company behind ChatGPT, which itself is making rumblings about going public and being spun off on its own. That was a headline from earlier this week. Major enterprise software player is Microsoft. And when they beat earnings, what that signals is that corporate IT spending is really strong. And that means growth, right? If big companies are looking to spend on their infrastructure, their networks and all that, they're not doing that for fun. They're doing that because they somehow sense an opportunity to make more money with the core products and services that they sell. That has ripple effects across the economy.
So, let's talk about OpenAI a little bit more. So, OpenAI is giving its... Microsoft is not the only owner. It doesn't own a OpenAI entirely, but it is a large shareholder. OpenAI is going to give Microsoft a 27% ownership stake, part of this restructuring plan that they've been negotiating for about a year. And that kind of removes one of the big obstacles, one of the big question marks we had out there for both sides. And it clears the path for ChatGPT to become a for-profit business on its very own. So, there's one good story happening in the economy. Bob, what else do you see out there?
Bob: Well, just to go back on this whole OpenAI, ChatGPT story, I mean, just as a reminder, you mentioned it, they're trying to become a for-profit business. They have extremely innovative technology, but they've yet to make a profit. So, what I'm hearing talked about in some of these analyst calls and all that is, these companies are going up because of the tremendous spend on AI infrastructure. And the chip stocks and everything else are following right along. But I think the question mark heading into next year is going to be, "All right, you guys are spending all this money. You obviously have smart people running these companies and you're monitoring profit and loss and expenses on a regular basis. We got to make sure these trillions of dollars of spending on OpenAI infrastructure actually yield some benefits in terms of continued growth." And that's the real question going into 2026.
But we will move on to the next company, Meta. They reported third quarter sales of $51.2 billion, which beat the average estimate from analysts. They've used profits from their advertising business to fuel their AI ambitions, leading to some anxiety among investors who were waiting to see, like we just talked about, how much profits are actually coming? And more in the near term, how much holiday quarter sales would help offset some of that spending? They were once just Facebook. Now, let's face it, they're a trillion dollar ad giant. So, if Meta is doing well, it tells us companies are confident enough to spend big on digital advertising. That's a good indicator of business sentiment. Their user numbers also hint at where attention and engagement are shifting because, let's face it, advertising is shifting to podcasts and digital and all that in a way from traditional media. It's a fascinating evolution to watch unfold in real time.
Brian: And not to be outdone, the artist formerly known as Google, Alphabet Incorporated, they reported quarterly sales, again, also ahead of analyst estimates. Remember, that's all we care about, folks. We don't care what the earnings actually were. We just care that it was better than what the analysts said it was going to be. But anyway, that came from the Cloud Unit within Google and Alphabet that is growing artificial intelligence startups. So, think Google's Gemini and that kind of thing. All these big companies have their own AI type of tools out there.
Similar to Meta, Google, of course, makes its money based off of ads. But that also tells us an awful lot about search trends. How are people engaging with each other over YouTube? And therefore, where's the profits to be found there? Cloud infrastructure through Google Cloud. And then, of course, Google being Google, they're a huge player in the AI race, just like these other companies. So, they're investing record amounts to try to really, really push AI to its limits and to get it to be a profitable business. I think there's a ways to go before this is truly profitable. But we once said that about Amazon as well, and they turned out okay.
Bob: Yeah. And then this discussion wouldn't be complete without, at least, mentioning the big kid on the block, Nvidia. I mean, that stock price is through the roof. It's done so, so well. And many investors are wondering, can this momentum continue? Believe it or not, Brian, when you look at the valuation of this stock, when you look at their actual earnings and sales growth, you can make a very good argument that is not priced very expensive relative to some of their peers. But I'm just one guy looking at data. The market will tell this tale.
And again, it's fascinating to watch if and how this whole AI thing is going to impact the overall economy. I mean, just listening to Dr. Mester talk and the Fed trying to balance labor with inflation, a lot of people are worried that AI is going to start replacing jobs that are never coming back. Others make the argument, if you look at any other technological innovation in this country, it's always created a bunch of jobs, just different jobs, that people never even knew existed or never expected to exist. So, it's going to be real fun to watch this all unfold in 2026 and beyond.
Brian: Yeah, and it is. That's a fascinating area to look at. And I think you're right. I remember when the internet was first a thing 30 years ago, how many jobs were going to be lost? Well, it ended up being the opposite because we wound up creating a bunch of jobs we hadn't thought of before as the internet provided new opportunities to make profit. So, I think at this point, that's the way we should be thinking about AI, not being overly afraid that it's going to wipe out everybody's job and we will all simply sit at home and wait for computers to bring us everything we need.
Bob: Here's the Allworth advice, earning season isn't just noise, it's insight. And the biggest tech names give us the clearest signal on where the economy and the markets might be heading next. Coming up next, we tackle some real listener questions from the tax surprise after selling mutual funds to the confusion around tax drag, and whether investing through an LLC can really make some sense. You're listening to "Simply Money", presented by Allworth Financial on 55KRC, THE Talk Station.
You're listening to "Simply Money", presented by Allworth Financial. I'm Bob Sponseller along with Brian James. Do you have a financial question you'd like for us to answer? There's a red button you can click while you're listening to the show if you're listening to the show on the iHeart app. Simply record your question, and it will come straight to us. John in Blue Ash leads us off tonight, Brian. He says, "I've heard that as rates fall, muni bonds could actually create phantom income for tax purposes. Is that true, Brian? And how do you plan ahead for it?"
Brian: Well, it is Halloween. Is the season to talk about phantom stuff that shows up on spreadsheets and tax returns. So, yeah, let's talk about phantom income. This is a real thing. So, here's an example. Let's This happens for some municipal bond investors sometimes. Let's say, you buy a muni bond at a discount, maybe $900 instead of its face value of $1,000. And as rates drop, the IRS assumes the bonds will go up as rates drop.
There's an inverse relationship there. The IRS assumes part of that gain every year is interest you earned, even though you haven't actually received a dime, yet. It's just on paper. That's called original issue discount. And it can show up as taxable income even when your muni is labeled as tax free, because that's kind of a capital gain in a roundabout way. Most likely affects people holding individual muni bonds in taxable accounts, not those in IRAs, which if you've done that, you're doing it wrong. Don't own muni bond and IRAs or bond funds, which will handle that accounting internally. All this stuff filters through on your 1099, so, you don't need to sort it out. But if you see a funny looking number on your 1099, talk to your CPA, talk to your advisor about it. But it may be phantom income. Boo, Bob. All right, let's move on to another question.
Bob: Pun intended.
Brian: It's a very timely questions today. Let's see how Kathy and Loveland is going to scare the bejesus out of us. So, Kathy says her tax bill jumped. Okay, that is scary. Tax bill jumped after selling some mutual funds. And so, she's wondering, how do these capital gains distributions sneak up even when you don't sell anything?
Bob: Well, Kathy, I'm sure you've lived through this. But for those that haven't, they sneak up on you through these distributions that come out in the fourth quarter of every year. And Brian and I talk about this all the time on the show. This kind of relates to the evolution of the whole investment industry over the last 10, 15, 20 years, where people are getting taxed on these mutual funds. And they might be fantastic mutual funds that you've owned for decades. But you don't have any control. You don't have absolute control from a tax standpoint. Meaning, depending on how long you've owned them or when you bought them, you might get handed a tax bill in the fourth quarter every year for gains that you didn't even participate in. And that's just a function of how mutual funds work, highlight the word mutual.
And this is why ETFs, your situation is individualized to you when you own an ETF, so you have much more tax control. So, how do you handle this? I think you sit down with a good, fiduciary advisor and a good CPA and you map out a strategy. Does it make sense for us to gradually transition into a more tax-efficient operation here moving forward? Whether that means direct indexing, ETFs, a mixture of both, with some good tax loss harvesting working in the background. Things really have evolved to the place where, again, gradually transitioning, you can put yourself in a much better position from a tax standpoint moving forward, Kathy. Hope that helps.
All right, Brian, Tom in Westchester says, 'We've got multiple layers of insurance. Umbrella insurance, life insurance, long-term care insurance. How do you coordinate all those policies so they actually work together?"
Brian: Yeah, so a lot of people build up their insurance coverage this way, one piece at a time, triggered by when they need it. So, maybe we start off with life insurance, then there's an umbrella policy, all of a sudden a little bit later, and then long-term care much later on. So, the problem is if you haven't coordinated all these different layers, you might wind up overpaying because these things overlap. You're paying for things twice or you're not paying for things at all because there's a gap between them. So, you're going to want to start off with just an inventory. What do you have? What does each policy cover and bullet that out? When does it pay off? What triggers the coverage? And how much protection does it actually provide?
So, for example, your umbrella policy should be on top of your home and auto limits, but only if those limits are high enough to trigger it, right? Make sure that's coordinated. Life insurance, there's really three things you're trying to cover there. You probably want to pay off any debt in the event of your untimely death, provide some liquidity immediately. And those numbers are relatively easy to get to. The harder one is the third, which is income replacement for your family. That's going to depend on, what does the family spend? And how much time do they need to cover those expenses coordinated with whatever income sources they will still have. But what I didn't say is a fat, round number from a long time ago. Make sure there's some logic behind this.
And finally, long-term care insurance, that interacts with both your retirement plan and your estate plan. You have a life policy, it may have a long-term rider on it, a long-term care rider. Double check and see if that's already there before you go out and buy a standalone policy. So, I hope that helps. There's a few steps there, but that is a complicated puzzle to put together sometimes. And hopefully, you've got an advisor out there available to help you figure it out.
Mark in Lebanon. Mark's considering investing through an LLC for privacy and liability reasons. And he's wanting to know what the tax trade-offs are there compared to just investing personally without the layer of the LLC. Bob?
Bob: All right, Mark. This is a loaded question. And I will say right off the bat, this is another situation. This is not a do-it-yourself proposition. This is not something you want to decide on yourself and just work this through TurboTax. You really do need to have a good CPA involved to help you evaluate these decisions. So, I think start, you know, if you sit down with your advisor and your CPA, I think the important thing, like everything else we talk about, what are your true objectives here?
So, you know, there are single-member LLCs, which basically get treated from a tax standpoint just as though you invested personally, so pretty simple. You know, depending on what you're trying to accomplish here, you know, if you have a multi-member LLC, well, now, you're getting into the situation where a K-1 has to be issued every year. And that can present delays for some of the participants. Some people don't like K-1s. So, I've had people tell me, "Bob, put me in any kind of investment you want, but as long as I never receive a K-1 for the rest of my life."
Now, there are some potential advantages to investing in an LLC, which means you can elect to be taxed as a C-corporation or an S-corporation in an LLC. So, again, it depends on what you're really trying to accomplish here. And that's why I say, sit down with a good CPA and hopefully your advisor and just really put things on the table on what you're trying to accomplish. And then you'll come up with the right tax structure to make it happen.
All right, coming up next, Brian has his bottom line where he's going to eliminate some of the confusion that's out there between, how does the Federal Reserve operate versus the Treasury Department. You're listening to "Simply Money", presented by Allworth Financial on 55KRC, THE Talk Station.
You're listening to "Simply Money", presented by Allworth Financial. I'm Bob Sponseller along with Brian James. And speaking of Brian James, Brian has his bottom line for us tonight where he's going to remove the confusion. Because we get questions all the time, "Hey, what's the difference between what the Federal Reserve does and what the Treasury Department does?" Brian, enlighten us.
Brian: Yeah, well, actually I'm going to push back on that just a bit, Bob. And nobody ever asks the question of the difference between the Treasury and the Fed. I think a lot of people who think about it don't know that there is a difference between these two organizations. And having just been honored by Dr. Loretta Mester visiting the show for us to ask her some very pointed questions and highly intelligent questions, I might add, Bob, I think we did a good job there. But I thought we'd go over kind of a little bit of the history and what these two organizations, the roles that they serve.
So, the Treasury, that's the Federal Government's finance and revenue arm. Its job is to collect the taxes, issue the debt, and printing coins and notes physically via those bureaus, managing the government's checking account, basically. Also made pretty famous in a recent musical called "Hamilton". The Federal Reserve, on the other hand, is not where the cool kids hang out and has not had a musical written about it. But its job is to be the US Central Bank. It's been around since 1913. And its job is, as Dr. Mester would explain to us, is managing that money supply, supervising the banks, setting short-term interest rates, and promoting maximum employment and stable prices. It's really, they always call it a split mandate between maintaining inflation and promoting maximum employment. That's really what the Federal Reserve is after.
So, really, the way these two organizations work together, the Treasury is part of the cabinet led by the Secretary of the Treasury and it has to follow the fiscal directions of Congress and the President. The Fed, on the other hand, is much more independent, has a Board of Governors on which she served. They report to Congress, but they're insulated so far anyway, from day-to-day politics, and that allows them to focus a little longer term.
Bob: All right, Brian, if you could pick your dream job, if you could be the Treasury Secretary of the United States or the Chairman of the Federal Reserve, which job would you want and why? And I have a feeling you're going to say neither.
Brian: Neither, Bob. You saw that coming, did you? I like my job where it's to explain to people what these two organizations do and why the decisions that they make have an impact on them. So, what is that? So, the tools that are used, the Treasury will issue debt and collects taxes, right? So, it has to determine how much the government's going to spend and borrow. The Fed sets the target for the federal funds rate. So, in other words, when the Treasury decides we have to borrow this much money, that's going to be impacted by whatever the Fed just did, such as the other day when we cut interest rates by a quarter of a point and now that we're in a declining rate environment.
So, why does this matter? Why do we care about any of this? Well, here's the impact on your wallet. When the Treasury runs large deficits or borrows a lot, which is, we've pretty much been in that mode for an awful long time, that influences long-term interest rates, influences the national debt, and therefore, how much tax or future burden households are going to have to face. On the other hand, when the Fed raises or lowers those interest rates, that will directly hit your mortgage rate, your auto loan rates, savings yields, even job market strength in your region. So, these are all things that have a strong impact on what we say and do. So, these are boring organizations. However, you have to realize that they do have a direct impact on your lifestyle.
Bob: Well, all I'll say is, if I ever become president of the United States, which the chances are slim and none of that is ever going to happen, I will nominate Dr. Mester to be the Fed chair. I found her interview to be very refreshing. She's very smart, obviously very articulate, and she'd be great standing in front of the media, just putting things in plain English, unlike what some of these current people do. I really love that interview and really so much appreciate her. I wish she was still serving on the Fed, to be honest with you. Thanks for listening. You've been listening to "Simply Money", presented by Allworth Financial on 55KRC, THE Talk Station.
If you follow the markets at all or even just have a mortgage, then you know that the Federal Reserve plays a massive role in your financial life. But the conversations that happen inside those closed door meetings in Washington, most of us never get to hear from someone who was actually in the room. That's why tonight is so special.
Until the middle of last year when her 10-year term concluded, Dr. Loretta Mester served as president and CEO of the Federal Reserve Bank of Cleveland, where she actually cast votes that directly shaped interest rates in the direction of the U.S. economy. And for those that don't know, the Cleveland Fed has a branch right here in Cincinnati. Dr. Mester currently is an adjunct professor of finance at the Wharton School of the University of Pennsylvania. Prior to joining the Cleveland Fed, she served at the Federal Reserve Bank of Philadelphia. And as if she does have any spare time, in her spare time, she serves as a trustee of the Cleveland Clinic and of the Musical Arts Association in Cleveland. Dr. Mester, it is a real treat to have you with us. Thank you so much for making time for us tonight.
Dr. Mester: Thanks for having me on. I'm really looking forward to the conversation.
Bob: Great. Well, hey, the timing of your being with us could not be much better as the Fed, as you well know, just voted to lower interest rates by a quarter of a percentage point yesterday. Do you have any reaction to that move? Are we on the right track here? And more importantly, and I've heard you interviewed on this through other media channels, give us a taste of your sense of the balance that the Fed is trying to strike here between getting inflation back down to that 2% target and balancing that with the health or lack thereof of the labor market.
Dr. Mester: Well, you're exactly right. I mean, the Fed does have a dual mandate goal, so called, that the Congress has given it. It has to hit price stability, which it defines as 2% inflation, and it has to set policy also to support getting the maximum employment. And so, balancing those at times can be challenging. And this is one of those times because, as you pointed out, the labor market, it's in a balance. I would call it an uneasy balance in that there isn't a lot of hiring going on, but there also isn't a lot of hiring going on. And so, you have sort of an equilibrium there for businesses where they just don't add a lot of people to their payroll because they don't want to get caught out with too many if the economy takes a turn. On the other hand, you also have inflation that after the surge, after the pandemic, you know, when the inflation went up really, really high to high levels, over 7%, hasn't ever come back down to the goal of 2%. And the Fed's been working hard to try to get that to come down.
So, they have to have both of those goals in their sights. And that's what they've been trying to do. Last meeting in September, they started to reduce interest rates, their policy rates, and they followed through with another rate cut this week, just yesterday. And so, you know, they're trying to take out some insurance on the labor side of their mandate, while at the same time, keeping some, you know, pressure to get inflation back down. And that's hard to do when you have the economy performing as it is. But so far, you know, that's what they're trying to do. And as the chair said yesterday in his press conference, Chair Powell, they're not sure what they're going to do in December now. You know, they'll have to wait and see how the economy evolves to see whether they need to do more or whether they're going to stand back.
Brian: Dr. Meister, it seems like we've been stuck at 3-ish% inflation for a long time now. And for an uneducated mind like myself, it almost feels like 3% is the new floor, especially since we decided to go ahead and start cutting interest rates, you know, before we got down to our preferred 2%. Why was it so much easier to get down from the crazy 9% down to 3%, but this last mile is so difficult? What would you say is the biggest hurdle to that?
Dr. Mester: Well, you're exactly right. And we have been sort of very, in some sense, stuck at 3%. You know, last year, they started to bring the interest rate down because they thought inflation was on its path down to 2%. You don't want to wait until inflation gets to 2% to move monetary policy into a more neutral stance because then, you'll overshoot, and have, you know, inflation prices keep falling. And that isn't necessarily good for the economy either. But you're right, and I have some concerns about the inflation numbers that, you know, they've been having a view that, you know, most of it is tariffs, right? So, when firms have to face higher costs to bring goods into the country, they'll increase their prices to consumers to try to make up for some of that higher cost.
And so, they've been saying that they think most of the inflation has been this care for later inflation, and they view that as being sort of a temporary phenomenon that'll go away. However, I think if you delve under the hood, you see that it's not just tariffs, that it's service prices, especially if you take out housing prices, which are starting to move back down. And so, I think they do need to be very watchful of that and not go too far on their rate cuts, because then, they'll embed that inflation in the economy. And as you point out, it's already been, you know, four and a half years since we've gotten inflation back down 2%, you know, has been at 2%. So, again, there is a difficult row to hoe, and they have a challenge in front of them. And so, that's why I think they really need to be focused on inflation and the labor market, not just on one of those two balls. They need to keep both on their site.
Bob: You're listening to "Simply Money" presented by Allworth Financial. I'm Bob Sponseller along with Brian James, joined by Dr. Loretta Mester, the former president and CEO of the Federal Reserve Bank of Cleveland.
Dr. Mester, we want to get into a little bit of your actual time serving on the Fed. I mean, let's face it, you served on the Fed as president of the Cleveland Fed during some interesting times. You served during most of the Obama administration, the first Trump administration, then almost all of the Biden administration. So, pretty interesting times, to say the least. And among the most interesting times, you were on the Federal Reserve helping us guide the country through COVID, one of the most historic periods in history and certainly a gut punch to the economy. Take us behind the scenes of how you tried and your colleagues operated during a time when, you know, let's face it, we weren't sure what was going to be going on here with this pandemic.
Dr. Mester: Well, you're exactly right. It certainly was nothing that any of us had experienced. And it was very uncertain. I mean, I think people sometimes forget, given that we're now five years beyond how uncertain it really was. And we didn't really understand what was going on, especially in the beginning. I remember sitting in a conference in New York after having gotten back from London early in March, and we were like sardines in a can. And I'm thinking, like, now, wow, that was pretty risky thing to do. But you didn't know at the time. And so, you know, we, as I said, all of the policymakers and all the staff at the Fed really hunkered down to really try to understand what was happening to the economy because we wanted to do what we could with our policy tools to support the economy as best we could.
And I have to give credit to all the business people that I talked to during those times because we really didn't have a clue about what was happening. It was really important for us to gather that information and from bankers and business people and labor market leaders in our district, you know, which includes Cincinnati, of course, as you mentioned, we have a branch there. People were so generous. You know, they were worried about their own business, their own family, and yet they were incredibly, you know, generous with their time and intel and telling us what they were seeing out there.
And I actually had the opportunity to serve on a non-partisan, a political council that Governor DeWine put together because he wanted to gather people who were really in the understanding, trying to understand what was happening in the economy in Ohio. And that was also, I felt like I could provide, at least, our insights from the Fed side in terms of what we were seeing in the economy, but also hearing from the business people on that. So, it was a very uncertain time, I would say. But I mean, one thing about the Fed is that everyone at the Fed is very dedicated to doing what he or she can do to support the economy. And, you know, as you saw in yesterday's meeting, not everyone has the same view necessarily, what is the best path? But everyone brings their ideas to the table, and then they discuss them. So, that was what we tried to do during the pandemic.
As you know, you know, the Federal Reserve banks, including the branch in Cincinnati, stayed open because we had to move cash. It was very important that people have access to cash during uncertain times and, in fact, demand for cash. And a lot of people go around today not having cash in their pocket. They don't have dollar bills in their pocket. They use their phone or, you know, credit cards or debit cards. But during those kind of uncertain times, people want cash. They want to physically have something in their hand. And so, that was really important. And all the workers in our cash operations, they were dedicated coming in, even though they were scared for their own family. You know, they were really dedicated to making sure that the financial system stayed afloat, including the payment system.
Brian: Dr. Meister, I want to ask you about something a little more recent. This Fed, this happened after your term, but just a few months ago, Erika McEntarfer, the commissioner of the Bureau of Labor Statistics, was let go from her position after a less than desirable July employment report, which isn't necessarily attributed to any one person. And then some other changes with regard to how we collect data, how we distribute it. So, you weren't in the role, of course, at the time. But what were your thoughts when you started to hear the news about how we were changing the information that people such as yourself were going to have in order to make decisions? What are the biggest things that you thought, "Oh, my gosh, how are they going to function without this kind of thing?"
Dr. Mester: Well, it is certainly true that the government's economic statistics, the Bureau of Labor Statistics, you know, have published both inflation data and employment data. Those reports are, you know, top notch reports on the U.S. economy. They give you a very good picture of what's happening in the economy. And, you know, not to have that data is a disadvantage. Now, on the other hand, there are other data sources that the Fed has available to them. Some of them are private sector data that are available to everyone. And also, the Fed collects its own data.
So, you know, before every, you know, meeting on interest rates, the Fed actually publishes what it calls the beige book. I'm sure you have seen that before and many of your listeners probably have seen it. And it's really a summary from every Reserve Bank of what they're seeing and hearing from contacts in the district. And it's a summary of the economy. And we put that out, the Fed puts that out before the FOMC meetings so everyone can share. I am sure that the Reserve Banks have really stepped up those efforts, given they don't have the gold standard of data from the federal government. And a lot of the Federal Reserves, including the Cleveland Fed, do their own kind of surveying of businesses, and then amalgamate them into indicators and put them out to the public to see as well.
So, I'm sure there's been very big effort going into sort of collecting that intel so that they do have a basis for understanding what's happening in the economy, and then also, what they can expect to happen in the future. And that's where the boards of directors of the Federal Reserve Bank and business advisory councils... When I was at the Cleveland Fed, we ran a lot of business advisory councils that were geographically or industry focused so that we would have those contacts to be able to ask people, "Hey, what do you planning to do with your prices? You're facing higher tariffs. Are you planning to pay for some of that by reducing your margins? Do you have that money to do that? Are you planning to pass them on to your customers? And do you think you'll be able to do that while customers demand space for your product?" And so, you have that as a real avenue for gathering information that can be very useful for policy.
Bob: All right, Dr. Mester, we got to take a short break. I know you're going to hang with us for a few more minutes, which we really appreciate. You're listening to "Simply Money", presented by Allworth Financial on 55KRC, THE Talk Station.
You're listening to "Simply Money", presented by Allworth Financial. I'm Bob Sponseller along with Brian James. If you can't listen to "Simply Money" every night, subscribe and get our daily podcast. Just search "Simply Money" on the iHeart app or wherever you find your podcast. We are back and continuing our conversation with Dr. Loretta Mester, who served as president and CEO of the Federal Reserve Bank of Cleveland from June of 2014 through June of 2024.
Dr. Mester, I've got a question I'm dying to hear your answer to. You know, obviously in the current environment... And we've already talked about, you've served under three different administrations. Now, we have the second Trump administration where he has wanted to kind of try to, for lack of a better term, direct Fed direction on true social. Give us the real answer on how this actually works behind the scenes, how the Fed governors actually communicate. Are you guys actually influenced at all by all this noise out there? How does it really work? I mean, you gave us a lot of reassurance about how the Fed operated during COVID. Talk about what it's really like here when all this, you know, what I'll say, rhetoric is flying around. Is that just noise that you all just tune out when you're actually doing your job?
Dr. Mester: Certainly, you tune all of that out. I am very confident that when each policymaker enters that room where they sit around the table to deliberate what's the best path for monetary policy, none of the outside influences affect how they're going about making their decisions. That said, I think it's very unfortunate that... You know, even that you had to ask me that question just shows how unfortunate a situation we're in. Because, you know, in the past, you know, presidents have tried to influence the Fed. Typically, it happens during election years where they want to gin up the economy and they would love to have you through the economy growing as they enter an election, and then they're less worried about inflation because that comes later. And that has happened in the past under other presidents in history.
But what's different this time is that it's so in the open, it's so unrelenting, and it's so vitriolic. And so, this is an unfortunate situation because it does lead to skepticism about how the Fed actually goes about making its decisions. But I know in that room, none of that answers. This is really about sitting on the table, deliberating what they're seeing in the economy and their various districts and for the nation. And what they believe with their tools is the best path for them to set that industry. And so, again, it's an unfortunate situation.
You want the Fed to be able to make its decisions independent of all these short-run political considerations because it actually leads to better monetary policy. There's lots of work in various countries that basically show, and in the U.S. as well, that when the central bank can make decisions based on what's best achieving price stability and maximum employment if that's part of their goal, you actually get lower inflation, and you don't have to pay a price into having more volatility or business cycle fluctuations on growth or unemployment. You actually get better outcome for the public. And so, that's why you really want to have the Fed be able to make its decisions without this influence attempt. And that's what's so unfortunate, it's a distraction that isn't helpful in any way.
Brian: Dr. Mester, you spent a lot of time in Ohio, and then, of course, you were responsible for a lot of the Midwest in your role. What do you see currently about this area in terms of opportunities, threats, and those kinds of things? Is Ohio specifically well positioned to navigate all this economically, or do you see challenges here?
Dr. Mester: Well, Ohio has a lot going for it. I mean, it was more manufacturing based than other parts of the country, and certainly, has more ties also to the auto industry. But on the other hand, it also has a very important service sector, including education and including health care. The Cleveland Clinic, of course, I'm on their board. They certainly are at a forefront in the nation and the world on health care. So, that's what's great about the district in Ohio. It's really that it has a very diverse economy. And diversity of your economy is what you want because then, you can get through periods where maybe the tariffs are challenging some manufacturing firms. But on the other hand, health care is still going to be in demand. Again, having diversity is very important, and that's what Ohio has.
The educational part of Ohio is also very important because it's creating the workers of the future, and that's very important. On the other hand, there are a lot of businesses doing a lot in terms of internship programs, the apprenticeship programs, so that we have sort of the workforce that can do a lot of the jobs that are going to be necessary as the economy evolves in the future.
Bob: It has been a huge week for company earnings. We're going to talk about that and later take your questions. You're listening to "Simply Money", presented by Allworth Financial on 55KRC, THE Talk Station.
You're listening "Simply Money", presented by Allworth Financial. I'm Bob Sponseller along with Brian James. When the companies that make up a third of the S&P 500's total capitalization make earnings announcements, it's a pretty big deal. Good news will drive the market, and the reverse can happen as well. So, let's delve into some of these actual companies, Brian, because we are getting some earnings news, you know, coming out as we speak. And we've gotten earnings over the last couple of days from some of these big tech giants.
Brian: Yeah, the big companies are producing their report cards here. So, let's start with Microsoft. Microsoft reported better than expected results for the fiscal first quarter. Revenue in the company's Azure cloud business jumped about 40%. That's obviously a pretty good run. And they're heavily involved in the AI revolution using Azure as well as OpenAI, which is the company behind ChatGPT, which itself is making rumblings about going public and being spun off on its own. That was a headline from earlier this week. Major enterprise software player is Microsoft. And when they beat earnings, what that signals is that corporate IT spending is really strong. And that means growth, right? If big companies are looking to spend on their infrastructure, their networks and all that, they're not doing that for fun. They're doing that because they somehow sense an opportunity to make more money with the core products and services that they sell. That has ripple effects across the economy.
So, let's talk about OpenAI a little bit more. So, OpenAI is giving its... Microsoft is not the only owner. It doesn't own a OpenAI entirely, but it is a large shareholder. OpenAI is going to give Microsoft a 27% ownership stake, part of this restructuring plan that they've been negotiating for about a year. And that kind of removes one of the big obstacles, one of the big question marks we had out there for both sides. And it clears the path for ChatGPT to become a for-profit business on its very own. So, there's one good story happening in the economy. Bob, what else do you see out there?
Bob: Well, just to go back on this whole OpenAI, ChatGPT story, I mean, just as a reminder, you mentioned it, they're trying to become a for-profit business. They have extremely innovative technology, but they've yet to make a profit. So, what I'm hearing talked about in some of these analyst calls and all that is, these companies are going up because of the tremendous spend on AI infrastructure. And the chip stocks and everything else are following right along. But I think the question mark heading into next year is going to be, "All right, you guys are spending all this money. You obviously have smart people running these companies and you're monitoring profit and loss and expenses on a regular basis. We got to make sure these trillions of dollars of spending on OpenAI infrastructure actually yield some benefits in terms of continued growth." And that's the real question going into 2026.
But we will move on to the next company, Meta. They reported third quarter sales of $51.2 billion, which beat the average estimate from analysts. They've used profits from their advertising business to fuel their AI ambitions, leading to some anxiety among investors who were waiting to see, like we just talked about, how much profits are actually coming? And more in the near term, how much holiday quarter sales would help offset some of that spending? They were once just Facebook. Now, let's face it, they're a trillion dollar ad giant. So, if Meta is doing well, it tells us companies are confident enough to spend big on digital advertising. That's a good indicator of business sentiment. Their user numbers also hint at where attention and engagement are shifting because, let's face it, advertising is shifting to podcasts and digital and all that in a way from traditional media. It's a fascinating evolution to watch unfold in real time.
Brian: And not to be outdone, the artist formerly known as Google, Alphabet Incorporated, they reported quarterly sales, again, also ahead of analyst estimates. Remember, that's all we care about, folks. We don't care what the earnings actually were. We just care that it was better than what the analysts said it was going to be. But anyway, that came from the Cloud Unit within Google and Alphabet that is growing artificial intelligence startups. So, think Google's Gemini and that kind of thing. All these big companies have their own AI type of tools out there.
Similar to Meta, Google, of course, makes its money based off of ads. But that also tells us an awful lot about search trends. How are people engaging with each other over YouTube? And therefore, where's the profits to be found there? Cloud infrastructure through Google Cloud. And then, of course, Google being Google, they're a huge player in the AI race, just like these other companies. So, they're investing record amounts to try to really, really push AI to its limits and to get it to be a profitable business. I think there's a ways to go before this is truly profitable. But we once said that about Amazon as well, and they turned out okay.
Bob: Yeah. And then this discussion wouldn't be complete without, at least, mentioning the big kid on the block, Nvidia. I mean, that stock price is through the roof. It's done so, so well. And many investors are wondering, can this momentum continue? Believe it or not, Brian, when you look at the valuation of this stock, when you look at their actual earnings and sales growth, you can make a very good argument that is not priced very expensive relative to some of their peers. But I'm just one guy looking at data. The market will tell this tale.
And again, it's fascinating to watch if and how this whole AI thing is going to impact the overall economy. I mean, just listening to Dr. Mester talk and the Fed trying to balance labor with inflation, a lot of people are worried that AI is going to start replacing jobs that are never coming back. Others make the argument, if you look at any other technological innovation in this country, it's always created a bunch of jobs, just different jobs, that people never even knew existed or never expected to exist. So, it's going to be real fun to watch this all unfold in 2026 and beyond.
Brian: Yeah, and it is. That's a fascinating area to look at. And I think you're right. I remember when the internet was first a thing 30 years ago, how many jobs were going to be lost? Well, it ended up being the opposite because we wound up creating a bunch of jobs we hadn't thought of before as the internet provided new opportunities to make profit. So, I think at this point, that's the way we should be thinking about AI, not being overly afraid that it's going to wipe out everybody's job and we will all simply sit at home and wait for computers to bring us everything we need.
Bob: Here's the Allworth advice, earning season isn't just noise, it's insight. And the biggest tech names give us the clearest signal on where the economy and the markets might be heading next. Coming up next, we tackle some real listener questions from the tax surprise after selling mutual funds to the confusion around tax drag, and whether investing through an LLC can really make some sense. You're listening to "Simply Money", presented by Allworth Financial on 55KRC, THE Talk Station.
You're listening to "Simply Money", presented by Allworth Financial. I'm Bob Sponseller along with Brian James. Do you have a financial question you'd like for us to answer? There's a red button you can click while you're listening to the show if you're listening to the show on the iHeart app. Simply record your question, and it will come straight to us. John in Blue Ash leads us off tonight, Brian. He says, "I've heard that as rates fall, muni bonds could actually create phantom income for tax purposes. Is that true, Brian? And how do you plan ahead for it?"
Brian: Well, it is Halloween. Is the season to talk about phantom stuff that shows up on spreadsheets and tax returns. So, yeah, let's talk about phantom income. This is a real thing. So, here's an example. Let's This happens for some municipal bond investors sometimes. Let's say, you buy a muni bond at a discount, maybe $900 instead of its face value of $1,000. And as rates drop, the IRS assumes the bonds will go up as rates drop.
There's an inverse relationship there. The IRS assumes part of that gain every year is interest you earned, even though you haven't actually received a dime, yet. It's just on paper. That's called original issue discount. And it can show up as taxable income even when your muni is labeled as tax free, because that's kind of a capital gain in a roundabout way. Most likely affects people holding individual muni bonds in taxable accounts, not those in IRAs, which if you've done that, you're doing it wrong. Don't own muni bond and IRAs or bond funds, which will handle that accounting internally. All this stuff filters through on your 1099, so, you don't need to sort it out. But if you see a funny looking number on your 1099, talk to your CPA, talk to your advisor about it. But it may be phantom income. Boo, Bob. All right, let's move on to another question.
Bob: Pun intended.
Brian: It's a very timely questions today. Let's see how Kathy and Loveland is going to scare the bejesus out of us. So, Kathy says her tax bill jumped. Okay, that is scary. Tax bill jumped after selling some mutual funds. And so, she's wondering, how do these capital gains distributions sneak up even when you don't sell anything?
Bob: Well, Kathy, I'm sure you've lived through this. But for those that haven't, they sneak up on you through these distributions that come out in the fourth quarter of every year. And Brian and I talk about this all the time on the show. This kind of relates to the evolution of the whole investment industry over the last 10, 15, 20 years, where people are getting taxed on these mutual funds. And they might be fantastic mutual funds that you've owned for decades. But you don't have any control. You don't have absolute control from a tax standpoint. Meaning, depending on how long you've owned them or when you bought them, you might get handed a tax bill in the fourth quarter every year for gains that you didn't even participate in. And that's just a function of how mutual funds work, highlight the word mutual.
And this is why ETFs, your situation is individualized to you when you own an ETF, so you have much more tax control. So, how do you handle this? I think you sit down with a good, fiduciary advisor and a good CPA and you map out a strategy. Does it make sense for us to gradually transition into a more tax-efficient operation here moving forward? Whether that means direct indexing, ETFs, a mixture of both, with some good tax loss harvesting working in the background. Things really have evolved to the place where, again, gradually transitioning, you can put yourself in a much better position from a tax standpoint moving forward, Kathy. Hope that helps.
All right, Brian, Tom in Westchester says, 'We've got multiple layers of insurance. Umbrella insurance, life insurance, long-term care insurance. How do you coordinate all those policies so they actually work together?"
Brian: Yeah, so a lot of people build up their insurance coverage this way, one piece at a time, triggered by when they need it. So, maybe we start off with life insurance, then there's an umbrella policy, all of a sudden a little bit later, and then long-term care much later on. So, the problem is if you haven't coordinated all these different layers, you might wind up overpaying because these things overlap. You're paying for things twice or you're not paying for things at all because there's a gap between them. So, you're going to want to start off with just an inventory. What do you have? What does each policy cover and bullet that out? When does it pay off? What triggers the coverage? And how much protection does it actually provide?
So, for example, your umbrella policy should be on top of your home and auto limits, but only if those limits are high enough to trigger it, right? Make sure that's coordinated. Life insurance, there's really three things you're trying to cover there. You probably want to pay off any debt in the event of your untimely death, provide some liquidity immediately. And those numbers are relatively easy to get to. The harder one is the third, which is income replacement for your family. That's going to depend on, what does the family spend? And how much time do they need to cover those expenses coordinated with whatever income sources they will still have. But what I didn't say is a fat, round number from a long time ago. Make sure there's some logic behind this.
And finally, long-term care insurance, that interacts with both your retirement plan and your estate plan. You have a life policy, it may have a long-term rider on it, a long-term care rider. Double check and see if that's already there before you go out and buy a standalone policy. So, I hope that helps. There's a few steps there, but that is a complicated puzzle to put together sometimes. And hopefully, you've got an advisor out there available to help you figure it out.
Mark in Lebanon. Mark's considering investing through an LLC for privacy and liability reasons. And he's wanting to know what the tax trade-offs are there compared to just investing personally without the layer of the LLC. Bob?
Bob: All right, Mark. This is a loaded question. And I will say right off the bat, this is another situation. This is not a do-it-yourself proposition. This is not something you want to decide on yourself and just work this through TurboTax. You really do need to have a good CPA involved to help you evaluate these decisions. So, I think start, you know, if you sit down with your advisor and your CPA, I think the important thing, like everything else we talk about, what are your true objectives here?
So, you know, there are single-member LLCs, which basically get treated from a tax standpoint just as though you invested personally, so pretty simple. You know, depending on what you're trying to accomplish here, you know, if you have a multi-member LLC, well, now, you're getting into the situation where a K-1 has to be issued every year. And that can present delays for some of the participants. Some people don't like K-1s. So, I've had people tell me, "Bob, put me in any kind of investment you want, but as long as I never receive a K-1 for the rest of my life."
Now, there are some potential advantages to investing in an LLC, which means you can elect to be taxed as a C-corporation or an S-corporation in an LLC. So, again, it depends on what you're really trying to accomplish here. And that's why I say, sit down with a good CPA and hopefully your advisor and just really put things on the table on what you're trying to accomplish. And then you'll come up with the right tax structure to make it happen.
All right, coming up next, Brian has his bottom line where he's going to eliminate some of the confusion that's out there between, how does the Federal Reserve operate versus the Treasury Department. You're listening to "Simply Money", presented by Allworth Financial on 55KRC, THE Talk Station.
You're listening to "Simply Money", presented by Allworth Financial. I'm Bob Sponseller along with Brian James. And speaking of Brian James, Brian has his bottom line for us tonight where he's going to remove the confusion. Because we get questions all the time, "Hey, what's the difference between what the Federal Reserve does and what the Treasury Department does?" Brian, enlighten us.
Brian: Yeah, well, actually I'm going to push back on that just a bit, Bob. And nobody ever asks the question of the difference between the Treasury and the Fed. I think a lot of people who think about it don't know that there is a difference between these two organizations. And having just been honored by Dr. Loretta Mester visiting the show for us to ask her some very pointed questions and highly intelligent questions, I might add, Bob, I think we did a good job there. But I thought we'd go over kind of a little bit of the history and what these two organizations, the roles that they serve.
So, the Treasury, that's the Federal Government's finance and revenue arm. Its job is to collect the taxes, issue the debt, and printing coins and notes physically via those bureaus, managing the government's checking account, basically. Also made pretty famous in a recent musical called "Hamilton". The Federal Reserve, on the other hand, is not where the cool kids hang out and has not had a musical written about it. But its job is to be the US Central Bank. It's been around since 1913. And its job is, as Dr. Mester would explain to us, is managing that money supply, supervising the banks, setting short-term interest rates, and promoting maximum employment and stable prices. It's really, they always call it a split mandate between maintaining inflation and promoting maximum employment. That's really what the Federal Reserve is after.
So, really, the way these two organizations work together, the Treasury is part of the cabinet led by the Secretary of the Treasury and it has to follow the fiscal directions of Congress and the President. The Fed, on the other hand, is much more independent, has a Board of Governors on which she served. They report to Congress, but they're insulated so far anyway, from day-to-day politics, and that allows them to focus a little longer term.
Bob: All right, Brian, if you could pick your dream job, if you could be the Treasury Secretary of the United States or the Chairman of the Federal Reserve, which job would you want and why? And I have a feeling you're going to say neither.
Brian: Neither, Bob. You saw that coming, did you? I like my job where it's to explain to people what these two organizations do and why the decisions that they make have an impact on them. So, what is that? So, the tools that are used, the Treasury will issue debt and collects taxes, right? So, it has to determine how much the government's going to spend and borrow. The Fed sets the target for the federal funds rate. So, in other words, when the Treasury decides we have to borrow this much money, that's going to be impacted by whatever the Fed just did, such as the other day when we cut interest rates by a quarter of a point and now that we're in a declining rate environment.
So, why does this matter? Why do we care about any of this? Well, here's the impact on your wallet. When the Treasury runs large deficits or borrows a lot, which is, we've pretty much been in that mode for an awful long time, that influences long-term interest rates, influences the national debt, and therefore, how much tax or future burden households are going to have to face. On the other hand, when the Fed raises or lowers those interest rates, that will directly hit your mortgage rate, your auto loan rates, savings yields, even job market strength in your region. So, these are all things that have a strong impact on what we say and do. So, these are boring organizations. However, you have to realize that they do have a direct impact on your lifestyle.
Bob: Well, all I'll say is, if I ever become president of the United States, which the chances are slim and none of that is ever going to happen, I will nominate Dr. Mester to be the Fed chair. I found her interview to be very refreshing. She's very smart, obviously very articulate, and she'd be great standing in front of the media, just putting things in plain English, unlike what some of these current people do. I really love that interview and really so much appreciate her. I wish she was still serving on the Fed, to be honest with you. Thanks for listening. You've been listening to "Simply Money", presented by Allworth Financial on 55KRC, THE Talk Station.